TIME VALUE

OF MONEY
 MEANING OF COST

▪ Time value of money means price which we paid for using that money

▪ Interest is the price /cost for using money.

▪ Interest = Future value – present value

आने वाले years की Value आज की Value

TIME VALUE OF MONEY CONCEPT

DISCOUNTING COMPOUNDING

When we convert future When we convert present

value into present value, value into future value, it
it is called discounting is called compounding

DISCOUNTING

In Discounting concept, we will study following:

(i) Present value of Single Amount
(ii) Present Value of Annuity
(iii) Present value of Perpetuity
(iv) Present value of Perpetual Growth

HOW TO CALCULATE PRESENT VALUE FACTOR (PVF)

AND
PRESENT VALUE ANNUITY FACTOR (PVAF)

Example 1
Rate of Interest = 10%
Calculate PVF for 5 years and PVAF for 5 years

Example 2
Rate of Interest = 18%
Calculate PVF for 6 years and PVAF for 6 years

Example 3
Rate of Interest = 8%
Calculate PVF for 10 years and PVAF for 10 years
 HOW TO CALCULATE PRESENT VALUE
1. PRESENT VALUE OF SINGLE AMOUNT
Present Value =
Amount receivable after n years X PVF at Rate after n years

Example 4
Mr. A will Receive Rs. 15,00,000 after 6 years. Calculate Present value
when Rate of Interest is 15%.

2. PRESENT VALUE OF ANNUITY

▪ When Amount Receivable each year is equal for fixed period of time, it
is called Annuity
▪ Present Value of Annuity is calculated as under =
Annuity X PVF at a Rate for n years

Example 5
Mr. A will Receive Rs. 2,00,000 for 5 years. Calculate Present value of
Annuity when Rate of Interest is 18%.

3. PRESENT VALUE OF PERPETUITY

▪ When Amount Receivable each year is equal for Infinite period of time,
it is called perpetuity.
▪ Present Value of Perpetuity is calculated as under =
Annuity
Rate of Interest

Example 6
Mr. A will Receive Rs. 5,00,000 for indefinite period. Calculate Present
value of Annuity when Rate of Interest is 12.5%.

4. PRESENT VALUE OF PERPETUITY WITH GROWTH

▪ In this case, Present value of perpetuity with growth is calculated as
under:
Annuity + Growth Rate
Rate of Interest

Example 7
Mr. A will Receive Rs. 5,00,000 for indefinite period with a Growth rate of
10%. Calculate Present value of Annuity when Rate of Interest is 16%.

Example 8
Mr. A will Receive Rs. 2,00,000 every year with a Growth rate of 10% in
first year and 2nd Year and thereafter 15% growth rate with perpetuity.
Calculate Present value of Annuity when Rate of Interest is 20%.

Example 9
Mr. A will Receive Rs. 1,50,000 every year with a Growth rate of 12% in
first 3 Year and from 4th year onward, 20% growth rate with perpetuity.
Calculate Present value of Annuity when Rate of Interest is 18%.
 INTERNAL RATE OF RETURN (IRR)
IRR is a rate at which present value of all future cash Inflows is equal to
Initial Amount of Investment made

HOW TO CALCULATE IRR

CASE I - When there is Single Cash Inflow and single out flow

Example 10
Mr. A will invest Rs. 10,00,000 today and will receive 25,00,000 after 25
years. Calculate IRR

Ans.
In this case, IRR is calculated with the help of calculator by 12 steps
model.

Example 11
Mr. A will invest Rs. 15,00,000 today and will receive 45,00,000 after 30
years. Calculate IRR

CASE II - When there is Many Cash Inflows with single out flow

Example 12
Mr. A will invest Rs. 15,00,000 today and will receive 5,00,000 per year
for 5 years. Calculate IRR

Ans.
In this case, IRR is calculated by Trial & Error method by taking two
rates

Example 13
Mr. A will invest Rs. 10,00,000 today and will receive following Amounts:
▪ 1st Year 4,00,000
▪ 2nd Year 5,00,000
▪ 3 Year
rd 5,50,000
▪ 4th Year 6,00,000
▪ 5th Year 4,50,000
Calculate IRR

Example 14
Mr. A will invest Rs. 20,00,000 today and will receive following Amounts:
▪ 1st Year 8,00,000
▪ 3rd Year 11,00,000
▪ 4th Year 10,00,000
▪ 6 Year
th 9,00,000
Calculate IRR
 TYPES OF INTEREST

SIMPLE INTEREST COMPOUND INTEREST

Compound interest is interest

Simple interest is a method of calculated on the initial
calculating interest on a loan or principal, which also includes all
investment where the interest is of the accumulated interest from
previous periods on a deposit or
calculated only on the principal
loan. It can be thought of as
amount. It does not take into "interest on interest," and it can
account any interest that has make a sum grow at a faster rate
been added to the principal, than simple interest, which is
unlike compound interest. calculated only on the principal
amount.

1. SIMPLE INTEREST

Under simple Interest, Future value (A) is calculated as under:

A = P x (1 + (p x i x t)

Where=
P = Principal Amount
i = rate of interest for the period
t = No of period

Example 15
Mr. A invested Rs. 10,000 today @ 10% p.a. How much amount he will
get after 5 years if there is simple rate of Interest

Example 16
Mr. A invested Rs. 20,000 today @ 10% for half year. How much amount
he will get after 4 years if there is simple rate of Interest

2. COMPOUND INTEREST

Under compound Interest, Future value (A) is calculated as under:

A = P x (1 + i)t
Where=
P = Principal Amount
i = rate
t = No of period

Example 17
Mr. A invested Rs. 20,000 today @ 10% p.a. How much amount he will
get after 5 years if there is compound rate of Interest
 IMPORTANT NOTES ON COMPOUND INTEREST

(1) Compounding Annually

▪ No of convertible period in a year (NOCPY) = 12/12 = 1
Months in a year
Months in compounding period

▪ Interest Rate (i) = Annual Rate (r)

NOCPY

If Annual Rate (r) is 10%, then i will be 10/1 = 10%

(2) Compounding Half yearly

▪ No of convertible period in a year (NOCPY) = 12/6 = 2
Months in a year
Months in compounding period

▪ Interest Rate (i) = Annual Rate (r)

NOCPY

If Annual Rate (r) is 10%, then i will be 10/2 = 5%

(3) Compounding Quarterly

▪ No of convertible period in a year (NOCPY) = 12/3 = 4
Months in a year
Months in compounding period

▪ Interest Rate (i) = Annual Rate (r)

NOCPY

If Annual Rate (r) is 10%, then i will be 10/4 = 2.5%

(4) Compounding Monthly

▪ No of convertible period in a year (NOCPY) = 12/1 = 12

Months in a year
Months in compounding period

▪ Interest Rate (i) = Annual Rate (r)

NOCPY

If Annual Rate (r) is 10%, then i will be 10/12 = 0.833%

Example 18
Mr. A invested Rs. 80,000 today @ 16% p.a. How much amount he will
get after 2 years if compounding is:
(i) Annually
(ii) Half yearly
(iii) Quarterly
(iv) Monthly
 HOW TO CALCULATE FUTURE VALUE
1. FUTURE VALUE OF SINGLE AMOUNT
Future Value =
Amount invested X FVF at Rate after n years

Example 19
Mr. A Deposited Rs. 15,00,000 today. Calculate future value after 6 years
when Rate of Interest is 15%.

2. FUTURE VALUE OF ANNUITY

▪ When Amount Invested each year is equal for fixed period of time, it is
called Annuity of Investment
▪ Future Value of Annuity is calculated as under =
Future value Annuity = Annuity X (1 + i) t x NOCPY - 1
i
▪ The above future value of annuity is calculated by assuming that
amount invested at the end of each year.

▪ If Annuity amount is invested at the beginning of each year, then

future value is calculated:
Future value as per above formula X (1 + i)

Example 20
Mr. A Invested Rs. 2,00,000 each year at the end of each year for 5
years. Calculate Future value of Annuity when Rate of Interest is 18%.

Example 21
Calculate Future value of Annuity in Example 20 if Amount invested each
year at the beginning of the each year.

Example 22
Mr. A Invested Rs. 5,00,000 each year for 8 years. Calculate Future
value of Annuity when Rate of Interest is 16% in following cases:
Case I – if Amount invested at the end of each year
Case II – if Amount invested at the beginning of each year

3. FUTURE VALUE IN OTHER CASES

Example 23
Mr. A Deposited Rs. 1,00,000 at the end of first year, 1,60,000 at the end
of 2nd year, 3,00,000 at the end of 3rd year and Rs. 4,00,000 at the end of
4th Year. Rate of Interest is 10% p.a.
Calculate Future value at the end of 4thYear
Ans. Rs. 10,56,700
Example 24
Mr. A Deposited Rs. 1,00,000 at the beginning of first year, 2,00,000 at
the beginning of 2nd year, 5,00,000 at the beginning of 3rd year and Rs.
6,00,000 at the beginning of 4th Year. Rate of Interest is 20% p.a.
Calculate Future value at the end of 4thYear
Ans. Rs. 19,92,960

Example 25
Calculate future value of Rs. 5,00,000 in 20 years if Rate of Interest are:
▪ First 5 years 10% p.a.
▪ Nest 5 years 12% p.a.
▪ Next 5 years 15% p.a.
▪ Next 5 years 20% p.a.

Ans. Rs. 71,02,623

LEVERAGE
 MEANING OF LEVERAGE
Leverage is a term which means influence or power where we analyze if
we use fixed cost, then what will be effect on a financial variable if
there is change in other financial variable

TYPES OF RISK

OPERATING RISK FINANCIAL RISK COMBINED RISK

This Risk is due to

use of operating
This Risk is due to use
fixed cost in This Risk is a
of Financial fixed cost
Business. product of both
in Business.
operating and
Eg.
Eg. Salaries, Rent, Financial fixed cost
Interest, Fixed
office & in Business.
preference dividend
Administrative
expenses

This is measured by This is measured by This is measured by

Operating Financial Combined
Leverage Leverage Leverage

OPERATING LEVERAGE

▪ This is represented by Degree of Operating Leverage (DOL)

▪ DOL is calculated by applying any of following formula:

▪ Formula 1 = Contribution
EBIT

▪ Formula 2 = Change of % in EBIT

Change of % in Sales

▪ Formula 3 = Combined Leverage

Financial Leverage

1
▪ Formula 4 =
% of Margin safety
 FINANCIAL LEVERAGE
▪ This is represented by Degree of Financial Leverage (DFL)
▪ DFL is calculated by applying any of following formula:

▪ Formula 1 = EBIT
EBT

▪ Formula 2 = Change of % in EPS

Change of % in EBIT

▪ Formula 3 = Combined Leverage

Operating Leverage

COMBINED LEVERAGE
▪ This is represented by Degree of Combined Leverage (DCL)
▪ DCL is calculated by applying any of following formula:

▪ Formula 1 = Operating Leverage X Financial Leverage

▪ Formula 2 = Change of % in EPS

Change of % in Sale

▪ Formula 3 = Contribution
EBT

Example 1

Particulars 2023 2024

Sales 10,00,000 15,00,000
Less: Variable cost 6,00,000 9,00,000
Contribution 4,00,000 6,00,000
Less: Fixed cost 1,50,000 1,50,000
EBIT 2,50,000 4,50,000
Less: Interest 1,00,000 1,00,000
EBIT 1,50,000 3,50,000
Less: Tax @ 40% 60,000 1,40,000
EAT 90,000 2,10,000
Divided by No of Equity shares 1,00,000 1,00,000
EPS 0.90 2.10

Calculate Various Types of Leverage

Example 2
Sales 25,00,000
Variable cost 60%
Fixed Cost 5,00,000
12% Debentures 6,00,000
Equity Share Capital (Rs. 10) 7,50,000

Calculate:
(i) OL,FL and CL
(ii) If Sales is increase by 60%, then how much change will be made in
EBIT & EPS
(iii) if Sale is Decreased by 40%, then how much change will be made in
EBIT & EPS

Example 3
Financial Leverage 5
Interest 1,00,000
Fixed Cost 2,00,000
Calculate Operating Leverage and Combined Leverage

Example 4
Operating Leverage 5
Fixed Cost 1,00,000
PV Ratio 40%
Calculate Sales
 CAPITAL
STRUCTURE
 MEANING OF CAPITAL STRUCTURES
▪ Capital structure refers to the way a company finances its operations
and growth through a combination of equity (ownership interest) and
debt (borrowed funds). It represents the mix of different sources of
funds that a company uses to finance its activities.

▪ A company's optimal capital structure is determined by various

factors, including its industry, size, profitability, and growth
prospects. A well-balanced capital structure can help a company
maximize its value and achieve its financial goals.

▪ In this chapter, we will study capital structure only in the form of

Debts and Equity. There will be no preference share capital in this
chapter

CALCULATION OF SOME IMPORTANT VALUE

1. VALUE OF FIRM

Value of firm means overall value of Firm/company. It is the sum of

value of equity and value of debts.

▪ Value of firm is calculated as under:

𝐄𝐁𝐈𝐓
▪ Method 1 =
𝐖𝐀𝐂𝐂 (𝐊𝐨)

▪ Method 2 = Value of Equity + Value of Debts

2. VALUE OF EQUITY

Value of Equity is calculated as under:

𝐄𝐚𝐫𝐧𝐢𝐧𝐠 𝐚𝐯𝐚𝐢𝐥𝐚𝐛𝐥𝐞 𝐟𝐨𝐫 𝐄𝐒𝐇
▪ Method 1 =
𝐊𝐞

▪ Method 2 = Value of Firm - Value of Debts

3. VALUE OF DEBTS

Value of Debts is calculated as under:

𝐈𝐧𝐭𝐞𝐫𝐞𝐬𝐭 𝐞𝐱𝐩𝐞𝐧𝐬𝐞𝐬
▪ Method 1 =
𝐊𝐝

▪ Method 2 = Value of Firm - Value of Equity

 4. WACC (WEIGHTED AVERAGE COST OF CAPITAL)

𝐄𝐁𝐈𝐓
WACC = x 100
𝐯𝐚𝐥𝐮𝐞 𝐨𝐟 𝐟𝐢𝐫𝐦

5. Ke (CAPITALIZATION RATE)

𝐄𝐚𝐫𝐧𝐢𝐧𝐠 𝐚𝐯𝐚𝐢𝐚𝐛𝐥𝐞 𝐟𝐨𝐫 𝐄𝐒𝐇

Ke = x 100
𝐯𝐚𝐥𝐮𝐞 𝐨𝐟 𝐄𝐪𝐮𝐢𝐭𝐲

Note:
Under this chapter, Ke is known as Capitalization rate

Example 1
EBIT Rs. 10,00,000
15% Debentures Rs. 20,00,000
Capitalization Rate 16%

Calculate value of Firm and overall cost of capital

Example 2
EBIT Rs. 20,00,000
15% Debentures Rs. 30,00,000
WACC (Ko) 13%

Calculate cost of Equity and Value of Equity

Example 3
EBIT Rs. 20,00,000
15% Debentures Rs. 25,00,000
Capitalization Rate 16%

Calculate value of Firm and overall cost of capital

Example 4
Make analysis in Example 3 in following cases:
▪ Case I – Increase Debts proportion in Capital structure and Reduce
Equity assume that there is no change in expectation of
equity shares holders, So, Ke will remain same.

▪ Case II - Increase Debts proportion in Capital structure and Reduce

Equity assume that there is increase in expectation of
equity shares holders, So, Ke will increase and overall cost
remain same.
 CAPITAL STRUCTURE THEORIES

▪ There is two types of theories in capital structures:

(i) Relevant Theories
(ii) Irrelevant Theories

▪ Relevant Theories are those theories in which if we increase

Debts in our capital structure, there is change in value of firm &
overall cost of capital (Ko)

▪ Irrelevant Theories are those theories in which if we increase

Debts in our capital structure, there will be no change in value
of firm & overall cost of capital (Ko)

▪ We have to study following theories:

(i) NET INCOME APPROACH (Relevant Approach)
(ii) NET OPERATING INCOME APPROACH (Irrelevant Approach)
(iii) TRADITIONAL APPROACH
(iv) MM APPROACH

1. NET INCOME APPROACH

(NI APPROACH)

▪ This Approach is a Relevant Approach. In this Approach,

following assumptions are made:
(i) There is only two types of Mix i.e. Equity & Debts
(ii) Debts is cheaper source of finance than equity
(iii) Kd and Ke will remain constant
(iv) Due to use of Debts which is cheaper source of finance,
WACC (Ko) will reduce and overall value of firm will
increase

Diagram

Cost of Capital

Debts (Leverage)
▪ Under NI Approach, there is no change in risk perception of
Equity shareholders when we increase the use of Debts

Equity Shareholders कहते हैं जितना Debts use करना चाहो करो हमें कोई
मतलब नह ीं है , हमारा required rate (Ke) constant रहे गा

HOW TO IDENTIFY QUESTION OF NI APPROACH

▪ In NI Approach Question, Ke will be given in Question

▪ Value of Firm will be calculated as under:

Value of Firm + Value of Debts

▪ We have to calculate WACC (Ko)

Example 5
EBIT Rs. 60,00,000
15% Debentures Rs. 80,00,000
Capitalization Rate 20%

Calculate value of Firm and overall cost of capital

2. NET OPERATING INCOME APPROACH

(NOI APPROACH)

This Approach is a Irrelevant Approach. In this Approach,

following assumptions are made:
(i) There is only two types of Mix i.e. Equity & Debts
(ii) Debts is cheaper source of finance than equity
(iii) Kd and Ko will remain constant due to which overall value of
firm will not change.
(iv) Due to use of Debts in capital structure, ESH will start to
perceive higher risk, due to which, Ke will increase.
Diagram

Cost of Capital

Debts (Leverage)
Example 6
EBIT Rs. 6,00,000
Ko 15%

Calculate value of Equity and overall Ke in each of following cases:

Case I – 10% Debentures are Rs. 7,50,000

Case II – 10% Debentures are Rs. 15,00,000
Case III – 10% Debentures are Rs. 30,00,000

Practice Question to be solved – 9

3. TRADITIONAL APPROACH

Under this Approach, a compromised view is presented where

following points are considered:
(i) There is only two types of Mix i.e. Equity & Debts
(ii) Debts is cheaper source of finance than equity
(iii) Kd is constant to some extent but after a point, lender will
start to perceive more risk, so Kd will Increase if we takes
more and more debts
(Ek Level tak Debts sasta milega, uske baad ye mahnga milne
lagega)

(iv) To some extent, Ke will remain constant. Gradually, it start to

increase and after a certain point, it increase very fast

(v) Initially, Ko will decrease, then it remain constant up to some

level, after that level, it start to increase and value of firm
start to decrease

Note: Optimum capital mix will be when value of firm is maximum

and Ko is minimum.
 4. MODIGILIANI & MILLER (MM) APPROACH

1958 1963
WITH OUT TAX WITH TAX

MM APPROACH WITH OUT TAX

▪ MM Approach uphold the view presented by NOI Approach.

▪ But NOI Approach had lack of behavioral justification and MM
Approach gives justification for Investor behavior.
▪ MM Approach is based on following assumptions:

(i) Capital Market is perfect

(ii) All Information's are freely available
(iii) No transaction cost exist on transfer
(iv) All Investors are rational
(v) No corporate tax exist
(vi) Firms can be grouped into equivalent risk class

CLASSIFICATION OF FIRM UNDER MM APPROACH

UNLEVERED FIRM LEVERED FIRM

When there is no debts in When firm is using Debts

the company and Equity both

Cost of Equity as per MM Approach is calculated as under:

(1) For Unlevered Firm = Ke is equal to Ko

(2) For Levered Firm =

Ke = Ko (unlevered firm) + (Ko – Kd) X Debts/Equity

Example 7
EBIT Rs. 25,00,000
Ko 16%
Calculate value of Equity and overall Ke in each of following cases:
Case I – When Company is using only Equity
Case II – company purchase 40% Equity and introduced 40%
Debts @ 10% p.a.
 MM APPROACH WITH TAX

▪ MM Approach with tax is a relevant approach or theory. As per

this approach, value of firm will increase when we increase
debts in capital structure due to Tax benefit.

▪ Value of Levered firm (Firm with Debts) is calculated as under:

Value of unlevered Firm XXX

+ Tax Benefits ( Debts X Tax Rate) XXX
Value of Levered Firm XXX

Example 8
Value of Unlevered Firm Rs. 25,00,000
Ko 9%
Now, Company is planning to purchase 30% equity and want to
introduce 30% Debts @ 6%. No change in EBIT.
Calculate:
(1) EBIT
(2) Value of firm
(3) Overall cost of capital (Ko)

Example 9
Value of Unlevered Firm Rs. 50,00,000
Ko 18%
Now, Company is planning to purchase 30% equity and want to
introduce 30% Debts @ 12%. No change in EBIT.
Calculate:
(1) EBIT
(2) Value of firm
(3) Overall cost of capital (Ko)

Ans. EBIT Rs. 15,00,000, Value of Levered Firm Rs. 56,00,000,

Ko 16.07%
 ARBITRAGE PROCESS

▪ Increase in Income by transferring Investments from one firm to

another firm is called Arbitrage Process

▪ In case of Arbitrage Process, Investments in overvalued firm are

sold and amount received is reinvested in under valued firm to
increase income.

Example 10
Firm X Firm Y

EBIT 60,000 60,000

7% Debts 3,00,000 --
Ke 12% 10%

An Investor hold 20% in Levered firm. How Arbitrage process will

apply

Example 11
Firm X Firm Y

EBIT 60,000 60,000

7% Debts 3,00,000 --
Ke 16% 10%

An Investor hold 20% in Unlevered firm. How Arbitrage process

will apply

STEPS IF INVESTOR TRANSFER FROM LEVERED TO

UNLEVERED FIRM
(1) Calculate income in levered firm
(2) Sell share in levered firm and also take loan from market in
same % of holding. Amount from sale of shares and loan amount
will be available fund to invest in unlevered firm
(3) Invest total available fund in unlevered firm.
(4) Calculate % of holding in unlevered firm =
Amount invested X 100
value of unlevered firm
(5) Calculate increase in income:
Income in unlevered firm xxx
Less: Interest on personal loan (xxx)
Net income in unlevered firm xxx
Less: Income in Levered firm (Step 1) (xxx)
Increase in Income
 STEPS IF INVESTOR TRANSFER FROM UNLEVERED TO
LEVERED FIRM

(1) Calculate income in Unlevered firm

(2) Sell share in Unlevered firm. Amount from sale of shares will be
available fund to invest in Levered firm
(3) Invest total available fund in Levered firm in both equity and
Debts in same proportion in which Equity and Debts was in
Levered firm
(4) Calculate % of equity holding in Levered firm =
Amount invested in Equity X 100
value of Equity in Levered firm
(5) Calculate increase in income:

Income in Levered firm (EAE X % of equity holding)) xxx

Add: Interest on Investments in Debts xxx
Total income in Levered firm xxx
Less: Income in Unlevered firm (Step 1) (xxx)
Increase in Income

Note:
If investor invest in new firm same % which he was holding in old
firm (Not Total Available Fund), then Income in both company will
be same and in this case, Investor will have some surplus fund
which he can Invest any where else.
EBIT/EPS
ANALYSIS
 MEANING

▪ EBIT – EPS analysis indicates to management the projected

EPS for different financial plans.
▪ Generally, management wants to maximize EPS if doing so
also satisfies the primary goal of financial management -
maximization of the owner’s wealth as represented by the
value of business, i.e. the value of firm’s equity.
▪ If the firm attempts to use excessive amounts of debt,
shareholders ( who are risk - averters) may sell their shares,
and thus its price will fall. While the use of large amount of
debt may result in higher EPS, but it may also result in a
reduction in the price of the firm’s equity.
▪ The optimum financial structure for a firm (that is, the use of
debt in relationship of equity and retained earnings as sources
of financing) should be the one which maximizes the price of
the equity.
▪ We choose that financial plan in which market value of share
is higher. If we can not calculate market value, then decision
will be taken on the basis of EPS.

Statement showing EPS

Particulars Rs.

Sales xxx
Less: Variable cost xxx
Contribution xxx
Less: Fixed Cost xxx
EBIT xxx
Less: Interest xxx
EBT xxx
Less: Tax xxx
EAT xxx
Less: Preference Dividend xxx
Earning Available for ESH xxx
Divided by No of Equity shares xxx
EPS xx
MPS (EPS x P/E Ratio) xxx
 ELECTION OF PLAN

▪ 1st Preference = Plan with highest Market Price will be

selected
▪ 2nd Preference = If Market price is neither given nor can be
calculated , then we select Plan with highest EPS.

EBIT/EPS ANALYSIS FOR NEW COMPANY

Example 1
A Ltd is a newly incorporated company which want to raise fund
of ₹ 50,00,000.
The Expected EBIT will be 20% of Capital employed. A Ltd has
following option to raise fund:
Option I – All Equity
Option II – 60% Equity and 40% Debts @ 10%
Option III – 60% Equity and 40% Preference Share Capital @ 12%
Option IV – 50% Equity and 30%, Debts @ 10%, 20% Preference
Share Capital @ 12%

The Tax rate is 40% and the face value of equity share of
company is ₹ 10 and Issued in Market @ ₹ 40.
Analyze which plan is Best

EBIT/EPS ANALYSIS FOR EXISTING COMPANY

Example 2
A Ltd is a company which has capital structure of ₹ 30,00,000 all
in the form of equity (Face value of ₹ 10) with EBIT of ₹ 4,50,000.
Now company is introducing a new product for which it require
additional fund of ₹ 20,00,000. The proportion of EBIT will remain
same in future. The company has following option to raise
additional funds:
Option I – All through Equity
(Issue price is ₹ 30 and Issue expenses is ₹ 5)
Option II – All through Debts @ 10%
Option III – All through Preference Share Capital @ 12%
Option IV – 40% Equity and 35%, Debts @ 10%, and Balance with
Preference Share Capital @ 12%

The Tax rate is 30%. Analyze which plan is Best

 FINANCIAL BREAK EVEN POINT
▪ Financial Break even point means level of profit at which EPS is
zero

▪ It is calculated as under:
When there is no Preference Share Capital

BEP = Amount of Interest

When there is Preference Share Capital

BEP = Amount of Interest + Preference Dividend

1-t

Example 3
Equity Share capital (₹ 10) ₹ 10,00,000
12% Debentures (₹ 100) ₹ 8,00,000
Tax Rate 40%
Calculate Financial Break even point

Example 4
Equity Share capital (₹ 10) ₹ 40,00,000
15% Preference share capital (₹ 100) ₹ 7,00,000
12% Debentures (₹ 100) ₹ 18,00,000
Tax Rate 30%
Calculate Financial Break even point

INDIFFERENCE POINT

Indifference point means that Level of EBIT at which EPS will be

same at different Capital Structure

▪ It is calculated as under:
𝐄𝐁𝐈𝐓 −𝐈 𝟏 −𝐭 −𝐏𝐃 𝐄𝐁𝐈𝐓 −𝐈 𝟏 −𝐭 −𝐏𝐃
=
𝐍𝐨 𝐨𝐟 𝐄𝐪𝐮𝐢𝐭𝐲 𝐒𝐡𝐚𝐫𝐞𝐬 𝐢𝐧 𝐏𝐥𝐚𝐧 𝟏 (𝐍 𝟏) 𝐍𝐨 𝐨𝐟 𝐄𝐪𝐮𝐢𝐭𝐲 𝐒𝐡𝐚𝐫𝐞𝐬 𝐢𝐧 𝐏𝐥𝐚𝐧 𝟏𝟐(𝐍 𝟐)

Example 5
Plan A Plan B
Equity Share capital (₹ 10) ₹ 20,00,000 ₹ 15,00,000
15% Debentures (₹ 100) -- ₹ 5,00,000
Tax Rate 40%
Tax Rate is 40%. Calculate Indifference point and also prepare
Indifference curve.
 WORKING
CAPITAL
MANAGEMENT
 MEANING OF WORKING CAPITAL
▪ Capital required for a business can be classified under two main
categories:
▪ Fixed Capital and
▪ Working Capital
▪ Every business needs funds for two purposes – for its establishment
and to carry out its day to day operations.
▪ Long term funds are required to create production facilities through
purchase of fixed assets such as plant, machine, land, building,
furniture etc. Investment in these assets represents that part of the
firm’s capital which is blocked on a permanent or fixed basis and is
called fixed capital.
▪ Funds are also needed for short-term purposes for the purchases of
raw material, payment of wages, other day to day expenses etc.
These funds are known as working capital.

ELEMENTS OF COST

ON THE BASIS OF BALANCE

ON THE BASIS OF TIME
SHEET CONCEPT

GROSS NET PARMANENT/ TEMPORARY/

WORKING WORKING REGULAR VARIABLE
CAPITAL CAPITAL WORKING WORKING
CAPITAL CAPITAL
TOTAL OF CURRENT
CURRENT ASSEST
ASSEST LESS
CURRENT
LIABILITIES SEASIONAL SPECIFIC
WORKING WORKING
CAPITAL CAPITAL

▪ Permanent working capital means which always be there in business

in the form of some current Assets.
▪ Variable working capital means excess of working capital over
permanent capital. Under variable, seasonal working capital is
required for seasonal demand and specific working capital for
covering extra ordinary contingencies.
 HOW TO CALCULATE WORKING CAPITAL
Particulars Amounts
Stock of Raw Material xxx
(Cost of Raw Material consumed x period of Holding) xxx
Stock of WIP xxx
(Working in Progress cost x Period of Processing) xxx
Stock of Finished Goods xxx
(Cost of Production x Period of Holding) xxx
Debtors (Cost of Credit Sale x Collection period) xxx
Estimated Amount of Cash & Bank (will be given)
Gross Working Capital xxx
Less: Current Liabilities
Creditors (Purchase cost RM x payment period) (xxx)
Outstanding Expenses (xxx)
(Expenses x Time Lag for payment)
Working Capital (Net) xxx
Add: Amount for contingencies (If given in Question) xxx
Total Working Capital xxx
Impotent Notes:
▪ While calculating cost of raw material stock, we need cost of raw
material consumed. If cost of raw material consumed is not given,
then we calculate as under:
Opening stock of Raw Material xxx
Add: Purchase cost of Material xxx
Less: Closing Stock of Raw Material (xxx)
Cost of Raw Material consumed xxx
If Cost of Opening and closing stock of Raw material not given, then
we consider purchase cost for calculation of Raw Material stock.

▪ While calculating Stock of WIP, we will assume Material cost incurred

100% and Labour and Overhead cost incurred is 50%.

▪ Cost of production will be taken cash cost of production. It means if

Depreciation is included in cost of production, then it will be
deducted.

▪ Debtors will be calculated on cost of credit sales and not on the sale
value of credit sales. But if cost of sale is not available, then credit
sale value will be considered for calculation of debtors

▪ Similarly, creditors are calculated by taking cost of credit purchase.

Example 1
Raw material cost per unit 160
Labour cost per unit 60
Overhead cost per unit 120
Profit 60
Sale Price per unit 400
Additional Information's
Raw Material period 1 month
Working progress period Half month
Finished goods holding period 1 month
Debtors collection period 2 months
Creditors payment period 1 months
Lag in payment of wages 1.5 weeks
Lag in payment of overhead 1 months
Unit produced during the year 2600 units
One month is equivalent to 4 weeks

Calculate working capital assuming 80% of Goods is

sold on credit basis and closing cash balance will be
Rs. 58,000

WHEN QUESTION REQUIRE TO PREPARE PROJECTED

PROFIT & LOSS STATEMENT AND BALANCE SHEET

Following steps are followed while preparing Projected Profit & Loss
and Projected Balance sheet:
▪ Calculate working capital as usual
▪ Prepare Projected Profit & Loss and Projected Balance sheet
▪ If Balance sheet not matched, then balancing figure will be either
Cash & Bank balance or Bank OD

Note:
While calculating working capital, Debtors will be calculated on the
basis of cost of credit sale but for showing the Debtors in Balance
sheet, Debtors will be calculated on the basis of Credit sale value

OPERATING CYCLE PERIOD

▪ Working capital forecast is based on the operational cycle concept

▪ The operational cycle refers to the period that a business enterprise

takes in converting cash back into cash.

▪ In the case of a manufacturing concern, the duration of time needed

to complete the chain of events from cash to production and back to
cash is termed as the “operating cycle”.

NORMAL OPERATING CYCLE IS CALCULATED AS UNDER

AVERAGE HOLDING PERIOD OF RAW MATERIAL = XXX

ADD: AVERAGE WIP PERIOD = XXX
ADD: AVERAGE HOLDING PERIOD OF FINISHED GOODS = XXX
ADD: AVERAGE COLLECTION PERIOD FROM DEBTORS = XXX
LESS: CREDITORS PAYMENT PERIOD = (XXX)
LESS: PAYMENT PERIOD FOR EXPENSES = (XXX)
OPERATING CYCLE PERIOD = XXX
 CALCULATION OF EACH ELEMENTS OF OPERATING
CYCLE

Raw Material Stock

(1) Raw Material holding period =
cost of raw material consumed per day

Cost of raw material consumed per day is calculated as under:

cost of raw material consumed in a year
365

Raw Material holding period may also be calculated as under:

Raw Material Stock X 365
cost of raw material consumed in a year

Stock of WIP Stock of WIP X 365

(2) WIP period = or
cost of production per day Total Cost of Production in a year

Stock of Finished Goods

(3) Finished goods holding period =
cost of Goods sold per day

or
Stock of Finshed Goods X 365
Total Cost of Goods sold in a year

Debtors
(4) Debtors collection period =
credit sale per day

Debtors X 365
or
Total Credit sale in a year

Creditors
(5) Payment period to creditors =
credit Purchase per day

Creditors X 365
or
Total Credit purchase in a year

Example 2
Stock of Raw Material 5,00,000
Stock of WIP 3,00,000
Stock of Finished Goods 6,00,000
Debtors 10,00,000
Creditors 4,50,000
Material consumption per day 12,500
Cost of production per day 20,000
Cost of sale per day 25,000
Total sale per day (40% id cash sale) 40,000
Total Purchase per day (25% is cash purchase) 30,000

Calculate Operating cycle period

Example 3
Stock of Raw Material 4,00,000
Stock of WIP 3,00,000
Stock of Finished Goods 5,00,000
Trade Receivable 6,00,000
Trade Payables 5,50,000

Raw Material consumed 35,00,000

Cost of production 50,00,000
Cost of sale 65,00,000
Sales (80% of Sale is credit) 80,00,000
Calculate Normal operating cycle period

INVENTORY MANAGEMENT

▪ The investment in inventory is very high in most of the

undertakings engaged in manufacturing, whole-sale and retail
trade.
▪ The amount of investment is sometimes more in inventory than
in other assets. About 90 per cent part of working capital is
invested in inventories.
▪ So, It is necessary for every management to give proper
attention to inventory management. A proper planning of
purchasing, handling, storing and accounting should form a part
of inventory management.

▪ An efficient system of inventory management will determine

▪ What to purchase
▪ How much to purchase
▪ From where to purchase
▪ Where to store, etc.

▪ The purpose of inventory management is to keep the stocks in

such a way that neither there is over-stocking nor under-
stocking.
▪ The over-stocking will mean reduction of liquidity and starving
of other production processes;
▪ Under-stocking, on the other hand, will result in stoppage of
work. So, The investments in inventory should keep in
reasonable limits.
▪ For Inventory management, we have to consider following:
(a) Economic Order Quantity
(b) Reorder Level
(c) Minimum Level
(d) Maximum Level
(e) Average Level
(f) Danger Level
 ECONOMIC ORDER QUANTIY (EOQ)
▪ When we order Inventory, then in addition to purchase cost, there is
two other cost, which are:
▪ Ordering cost: Cost to place an order
▪ Carrying cost: Cost to carry the inventories

▪ EOQ means Quantity ordered at one time in such a way that ordering
cost and carrying cost should be minimum and equal

▪ EOQ is calculated as under = 2AO

C
▪ A = Annual consumption
▪ O = Ordering cost per order
▪ C = Carrying cost per unit per annum

Total Ordering cost and carrying cost is calculated as under:

Total quantity to be ordered in a year
▪ Ordering cost = x ordering cost per order
EOQ
EOQ
▪ Carrying cost = x Carrying cost per unit
2

Example 4
Annual Requirement of Material 2,50,000 unit
Purchase price per unit ₹ 50
Ordering cost per order ₹ 125
Carrying cost per unit p.a. 5%

Calculate EOQ and Total of ordering and carrying cost

Example 5
Assume in Example 4, that supplier agree to give discount @ 4% if
we order 5000 units at one time. Should we accept the offer.

SETTING OF STOCK LEVEL

(1) Re order Level = It means at which level, w should make next
purchase order. It is calculated as under:
Re order Level = Maximum usage x Maximum lead time

(2) Minimum Level = It means a level of stock below which a stock

should not go in normal situation.
Minimum Level is calculated as under:
Reorder Level – (Average usage X Average lead time

(3) Maximum Level = It means a level of stock which should be

maximum at all time
Minimum Level is calculated as under:
Reorder Level + Re order Quantity - (Minimum usage X
Minimum lead time)
(4) Average Level = Average Level is calculated as under:
Reorder Level + ½ of Re order Quantity
or
Minumum Level + Maximum Level
2
First formula is first preference and 2nd Formula is second
Preference.

(5) Danger Level = At any time, stock should not be lower than
Danger level
Danger Level is calculated as under:
Average usage x maximum lead time for emergency purchase

Example 6
Two components X and Y are used as follows:
Normal usage 300 units per week
Maximum usage 450 units per week
Minimum usage 150 units per week
Reorder Quantity X – 2,000 units and Y – 4,000 units

Re-order Period X – 4 to 6 weeks

Y – 2 to 4 weeks
Calculate
(1) Re-order Level, (2) Maximum Level, (3) Minimum Level (4)
Average Level.

ABC ANALYSIS
▪ This is a system of Inventory control.
▪ Under this system, Inventories are divided into three part:
(1) Category A: In this category, Inventories which are Approx
60 to 70% in value but only 10-15% in Quantity are
considered.

(2) Category B: In this category, Inventories which are Approx

20 to 30% in value as well as in Quantity are considered.

(3) Category C: In this category, Inventories which are Approx

10 to 15% in value but in 60 to 70% in Quantity are
considered.

Control:
Most emphasis point will be given on category A, Moderate
control is needed for category B and least control is required for
category C
 CASH MANAGEMENT

▪ Cash is one of the current assets of a business. It is needed at

all times to keep the business going.

▪ A business concern should always keep sufficient cash for

meeting its obligations.

▪ Any shortage of cash will hamper the operation of a concern

and any excess of it will be unproductive.

▪ Cash is the most unproductive of all the assets. While fixed

assets like machinery, plant, etc. and current assets such as
inventory will help the business in increasing its earning
capacity, cash in hand will not add anything to the concern.

CASH BUDGET

▪ Cash Budget means estimation of cash received in future from

various sources & Disbursement of cash while running business
in future.

▪ Cash Budget is prepared for future period

FORMAT OF CASH BUDGET FROM JAN TO MARCH

Particulars Jan Feb March

Opening Balance xxx xxx xxx
Cash Received
Cash Sales xxx xxx xxx
Collection from Debtors xxx xxx xxx
Other Received xxx xxx xxx
Total A xxx xxx xxx
Payment
Cash purchase xxx xxx xxx
Payment to creditors xxx xxx xxx
Payment of Expenses xxx xxx xxx
Other payment xxx xxx xxx
Total B xxx xxx xxx
Closing Balance (A – B) xxx xxx xxx
Example 7

HOW MUCH SHOULD BE MAINTANED AT A TIME

▪ Optimum cash balance means a Cash Balance to be maintained

where holding cost of cash (Opportunity cost) and Transaction
cost of converting securities into cash are minimum.

▪ For this purpose a model is given by Baumol which is called

Baumol model.

▪ Baumol is applied when annual requirement of cash is certain.

Under Baumol model, optimum cash balance is given as under:
2AT
O

▪ A = annual requirement of cash

▪ Transaction cost per conversion
▪ Opportunity cost p.a. in % (Holding cost of cash)
▪ The above formula is based on EOQ concept of Inventory
management.

▪ At optimum cash balance as per Baumol Model, Total

Transaction cost and Total opportunity cost are minimum and
equal.

Example 8
Annual Requirement of Cash ₹ 20,00,000
Cost of conversion of security into cash ₹ 100
Rate of Return 25%
Carrying cost per unit p.a. 5%

Calculate optimum cash balance as per Baumol Model and Total

cost.

RECEIVABLE MANAGEMENT
For Receivable Management, Finance manager of an entity
decide:
▪ Whether or not credit allowed to customers
▪ If yes, then to whom credit should be allowed
▪ How much amount of credit should be given
▪ How much period should be allowed for credit

We have to decide which policy is better out of many on the basis

of following statement:
Total Sale/Revenue xxx
Less:
Variable cost xxx
Fixed cost xxx
Cost of administration of Debtors xxx
Expected Bad Debts /Cash discount xxx
Cost of Fund (opportunity cost) xxx
Net Benefits xxx

Cost of Fund means opportunity cost which is calculated as

under:
(Variable cost + Fixed Cost) x Rate x Average collection period
365/52/12
SECURITY
ANALYSIS
 MEANING OF SECURITY
▪ These are Instruments for raising of Funds in the market.
▪ Securities are defined under section 2(h) of securities contract
(Regulation) Act, 1956

TYPES OF SECURITIES

DEBTS EQUITY DERIVATIVES

Instruments which
derives its value
These are in the This is residual from another
forms of Loan Interest in an entity underline and will
be settled on a
future date

MEANING OF INVESTMENTS

▪ It means putting/invested money in an Asset for generating returns by

way Interest, dividend or capital appreciation.
▪ Investments are made after considering following objectives:
▪ Security
▪ Liquidity
▪ Yield or Return

OBJECTIVES OF INVESTMENTS

1. Security

▪ Main objective of Investments is the certainty in recovery of the

principal.

▪ One can afford to lose the returns at any given point of time, but s/he
can not afford to lose the very principal itself.

▪ By identifying the importance of security, we will be able to identify

and select the instrument that meets this criterion.

▪ For example, when compared with corporate bonds/Equity, we can

see the safety of return of investment in Govt treasury bonds as we
have more faith in governments than in corporations.
 2. Liquidity

▪ The investments should be Liquid so that we can realize them on

short notice in case of urgency.

▪ They should be cashable at short notice, without loss and without any
difficulty.

▪ If they cannot come to our rescue, we may have to borrow or raise

funds externally at high cost and at unfavorable terms and conditions.

3. Yield/Return

▪ Yield means the net return out of any investment.

▪ Hence given the level or kind of security and liquidity of the

investment, the appropriate yield should encourage the investor to
go for the investment.

▪ If the yield is low compared to the expectation of the investor, s/he

may prefer to avoid such investment and keep the funds in the bank
account or in worst case, in cash form in lockers. Hence yield is the
attraction for any investment and normally deciding the right yield is
the key to any investment.

MEANING OF SPECULATION
▪ It is an act of Generating higher profit based on the rumor in the
market

▪ It involves high risk and high rate of return

▪ It is short term in nature.

▪ Speculators generally uses borrowed funds

▪ Primarily, the return is in the form of price change

MEANING OF GAMBLING/BETTING

▪ It is earning with entertainment generally with unplanned activity

▪ It is generally based on Tips and Rumors

▪ It involves high risk and high rate of return or it may have negative
returns
 SECURITY ANALYSIS
▪ Security Analysis is a process where we try to predict the price of
securities so that we can decide whether to purchase the security or
not for investment purpose.

TYPES OF SECURITY ANALYSIS

FUNDAMENTAL ANALYSIS TECHNICAL ANALYSIS

In this case, we makes In this case, we makes

analysis of : analysis based on :
▪ Economy ▪ Past trends
▪ Industry ▪ Charts
▪ Company ▪ Indicators etc.

1. FUNDAMENTAL ANALYSIS

▪ In fundamental Analysis, we try to find out whether a security is

fundamentally strong or not.

▪ It is a process to analyze the overall external and internal environment

of the company.

▪ Under Fundamental analysis, we make following Analysis:

(a) Analysis of Economy
(b) Analysis of Industry
(c) Analysis of Company

(a) ANALYSIS OF THE ECONOMY

▪ In this case, overall analysis of Economy of a country is made.

▪ If the economy of a country is growing, then it will be assumed that all
industry in that country will also grow or vice versa.
▪ Under economy analysis, following factors are studied:
(i) GDP
(ii) Savings and Investments
(iii) Inflations
(iv) Interest Rates
(v) Budget
(vi) Tax structure of the country
(vii) Other Factors such as Monsson, Agricultures, Infrastructures
etc.
 (b) ANALYSIS OF THE INDUSTRY
Industry is a combination of or group of units whose end products and
services are similar having a common market, the participants in the
industry group face similar problems and opportunities.

CLASSIFICATION OF THE INDUSTRY

CLASSIFICATION ON THE CLASSIFICATION ON THE

BASIS OF GROWTH BASIS OF STAGE

CLASSIFICATION ON THE BASIS OF GROWTH

In this case, Industry are classified into 3 categories:

(i) Growing Industry: Industries which are in Growing face, such

technology industry which are in growing face in India

(ii) Cyclical Industry: These are Industry in which growth is depend on

other industries. For Example, Construction material Industry growth
will depend how Real estate or construction industries are growing.

(iii) Defensive Industry: Theses are Industries which moves impudently

and does not affected with growth of other Industries
(Industries of Necessity Goods & Services i. e. FMCG, Medicine etc.)

CLASSIFICATION ON THE BASIS OF STAGE

In this case, Industry are classified into 3 categories:

(i) Pioneer Stage: In this stage, Industry grow at fast rate. In this case,
new products are launched, there may be extra ordinary profits and
due to competition, less efficient players may exit.

(ii) Expansion stage: In this case, Growth rate is slow because in this
stage, there is low volatility. At this stages, there will be high
accumulated reserve & surplus

(iii) Stagnation stage: In this case, there is no innovation, so Growth rate

starts declining.
 (c) ANALYSIS OF THE COMPANY
▪ Apart from economic and industry Analysis, the analyst looks at the
company specific information also.

▪ Company information is generated internally and externally.

▪ The principal source of internal information about a company is its

financial statements.

▪ In company specific analysis, following items are analyzed:

▪ Ratio Analysis:
▪ Comparative Financial Statement:
▪ Trend Analysis:
▪ Common size financial statement:
▪ Fund flow Analysis:
▪ Cash flow statement:

2. TECHNICAL ANALYSIS

▪ Technical Analysis is an analysis for forecasting the direction of

prices through the study of past market data, primarily price and
volume.

▪ This Technique assumes market prices of securities are determined by

the demand- supply equilibrium.

▪ It is based on the fact that history repeat itself.

▪ It is statical technique to predict future price. Under this technique, studies

are made through charts , graphs which are related to past market data,
volume and prices.
 TECHNICAL INDICATORS

▪ Apart from the charts, technical analysts use a number of indicators

generated from prices of stocks to finalize their recommendations.
These indicators are often used in conjunction with charts.

▪ Some of the important indicators are the Advance Decline Ratio, the
Market Breadth Index and Moving Averages.

TYPES OF INDICATORS

(A) ADVANCE-DECLINE RATIO

▪ It is the ratio of the number of stocks that increase to the number of

stocks that have declined. If the ratio is more than one, the trend is
assumed to be bullish. If the ratio starts declining, a change of trend
is signaled.

▪ It is used to analyze market breadth. It compares the number of

stocks that have advanced (increased in price) to the number of
stocks that have declined (decreased in price) over a specific period.
This indicator is often used to assess the overall health of the market
and to spot trends.

▪ Advance-Decline Ratio (ADR) is calculated as under:

Number of Advancing Stocks
Number of Declining Stocks

Interpretation
▪ ADR > 1: Bullish sentiment, indicating a stronger or rising market.
▪ ADR < 1: Bearish sentiment, suggesting a declining market.
▪ ADR = 1: Neutral, meaning the number of advancing and declining
stocks are equal, indicating a flat or balanced market.

Example:
In a particular day, trading on the stock exchange are:
▪ 900 stocks have advanced (prices increased)
▪ 600 stocks have declined (prices decreased)
 (B) MARKET BREADTH INDEX

▪ This index is a variation of the Advance-Decline Ratio. This index is

computed by taking the difference between the number of stocks
rising and the number of stocks falling.

▪ Market Breadth Index (MBI):

MBI= Advancing stocks − Declining stocks

▪ If during a month, 800 out of 2000 stocks in the market have risen and
600 have declined while 600 have remained unchanged, then market
breadth would be calculated as:

MIB = 800 – 600 = 200

▪ The figure of each time period is added to the previous period. If

market breadth is increasing along with rise in stock indices, it
confirms the bullish trend and vice versa.

(C) MARKET BREADTH INDEX

A moving average is the average of share values of a set of consecutive

number of days. If we have to calculate 50 days moving average, we
calculate the average for days 1–50. Then on day 51, we add the value
of day 51 and deduct the value of day 1 and so on . Similarly, moving
averages for 100 days, 200 days and 300 days can be calculated. Moving
averages provide a benchmark for future valuation. If share value is
below the moving average, it has scope for appreciation. If the value is
above the moving average, the upside is limited in the near term.

(D) MARKET BREADTH INDEX

The Relative Strength Index (RSI) is a popular momentum oscillator

used in technical analysis to measure the speed and change of price
movements of a security. It helps traders determine overbought or
oversold conditions in the market and spot potential reversals.
100
RSI = 100 -
1 + RS
Average Gain Per Day
Relative Strength (RS) =
Average Loss Per Day

The RSI can be calculated for any number of days depending on the
wish of the technical analyst and the time frame of trading adopted in a
particular stock market. RSI is calculated for 5,7,9 and 14 days. If the
period taken is more, the possibility of getting wrong signals is reduced.
Reactionary or sustained rise or fall in the price of the scrip is foretold
by the RSI.
 Example: Calculate RSI form following Details

Date Price

April 1 400

April 6 406

April 7 420

April 8 417

April 9 421

April 12 435

April 16 430

April 20 434

April 24 440

April 30 421

(E) AROON INDICATOR

The Aroon Indicator is a technical analysis tool used to identify trends in

the price of an asset and gauge the strength of that trend. It helps
traders determine whether a market is trending, how strong the trend is,
and whether a reversal is likely to occur. The Aroon Indicator consists
of two lines:
1. Aroon Up: Measures how long it's been since the highest price over a
given period.

2. Aroon Down: Measures how long it's been since the lowest price over
the same period.

Formula:
Aroon UP: 25 – Periods Since 25 period High x 100
25

25 – Periods Since 25 period Low

Aroon Down: x 100
25

The Aroon calculation requires the tracking of the high and low prices,
typically over 25 periods
Interpretation:
▪ Aroon Up close to 100: Indicates a strong uptrend (the recent high
occurred very recently).

▪ Aroon Down close to 100: Indicates a strong downtrend (the recent

low occurred very recently).

▪ Aroon Up and Aroon Down both low (close to 0): Suggests

consolidation or no clear trend.

▪ Aroon Up crossing above Aroon Down: Signals the beginning of an

uptrend.

▪ Aroon Down crossing above Aroon Up: Signals the beginning of a

downtrend.

▪ Close to 100 Can be taken 70% or above

Example:
calculate the Aroon Indicator for a stock over a 25-day period.
▪ The most recent high occurred 6 days ago.
▪ The most recent low occurred 20 days ago.

(G) PRICE RATE OF CHANGE

▪ The Price Rate of Change (ROC) is a momentum oscillator that
measures the percentage change in price between the current price
and a price from a set number of periods in the past.

▪ It helps traders gauge the speed at which the price is changing and
can indicate overbought or oversold conditions, as well as potential
trend reversals.
▪ ROC is calculated as under:
Current Price − Price n Periods Ago
Price n Periods Ago

Where:
▪ Current Price is the price of the asset today.

▪ Price n Periods Ago is the price of the asset n periods (e.g., days) ago.

▪ n is the number of periods chosen (commonly 10 or 14 days).

Interpretation:
▪ Positive ROC: Indicates that the price is rising compared to n periods
ago (bullish momentum).

▪ Negative ROC: Indicates that the price is falling compared to n

periods ago (bearish momentum).

▪ ROC near 0: Indicates little to no price movement, implying a period of

consolidation or sideways movement.

Example:
calculate 10-day ROC for a stock:
Current Price: Rs. 525
Price 10 Days Ago: Rs.500

FUNDAMENTAL VS TECHNICAL ANALYSIS

▪ In the fundamental analysis, share prices are predicted on the basis of
a three stage analysis (Economy, Industry & Company), After the
analysis has been completed, the deciding factors that emerge are the
financial performance indicators like earnings and dividends of the
company.
▪ The fundamentalist makes a judgement of the equity share value with
a risk return framework based upon the earning power and the
economic environment.

▪ However, in actual practice, it often happens that a share having

sound fundamentals refuses to rise in value and vice versa. In that
case, we examine an alternative approach to predict share price
behavior. This approach is Technical Analysis. It is used in
conjunction with fundamental analysis and not as its substitute.

▪ Technical analysis is an analysis for forecasting the direction of prices

through the study of past market data, primarily price and volume. This
Technique assumes market prices of securities are determined by the
demand- supply equilibrium. The shifts in this equilibrium give rise to
certain patterns of price and volume of trading which have a tendency
to repeat themselves over a period of time.
 RISK ANALYSIS
▪ Risk in security analysis is generally associated with the possibility
that the realized returns will be less than the returns that were
expected.
▪ In finance, different types of risk can be classified under two main
groups:
(a) Systematic risk and
(b) Unsystematic risk.

(a) SYSTEMATIC RISK

▪ Systematic Risk are uncontrollable, external and broad in their
effect are called sources of systematic risk.

▪ Systematic risk is due to the influence of external factors on an

organization. Such factors are normally uncontrollable from an
organization’s point of view.

▪ Systematic risk is a macro in nature as it affects a large number of

organizations operating under a similar stream or same domain. It
cannot be planned by the organization.

TYPES OF SYSTEMATIC RISK

Purchasing power
Interest Rate Risk Market Risk
or inflationary risk.

Purchasing power
risk is also known
It is variation in
Market risk is as inflation risk.
Interest rate due to
associated with originates from the
fluctuation in
consistent fact that it affects a
Market Rate
fluctuations seen in purchasing power
specially in Debts
the trading price of adversely. It is not
securities which
any particular shares desirable to invest
carry Fixed Interest
or securities in securities during
Rate
an inflationary
period.
 (b) UNSYSTEMATIC RISK
▪ Unsystematic risk is due to the influence of internal factors
prevailing within an organization.

▪ Internal factors are peculiar to a particular industry or firm/(s) & Such

factors are controllable.
▪ It may be because of change in management, labour strikes which
will impact the returns of only specific firms which are facing the
problem.

▪ It is a micro in nature as it affects only a particular organization. It

can be planned, so that necessary actions can be taken by the
organization to mitigate (reduce the effect of) the risk.

▪ Higher proportion of unsystematic risk is found in firms producing non-

durable consumer goods. Examples include suppliers of telephone,
power and food stuffs.

TYPES OF UNSYSTEMATIC RISK

Business or liquidity risk Financial or credit risk

Purchasing Financial risk is

Business risk is also known as also known as credit risk. It
liquidity risk. it originates from arises due to change in the
the sale and purchase of capital structure of the
securities affected by organization. The capital
business cycles, structure mainly comprises of
technological changes, etc. three ways by which funds are
sourced for the projects.

APPROCHES TO VALUATION OF SECURITIES

Fundamental Technical Efficient

Approach Approach Capital
(Intrinsic (Trend on the Market
Value) basis of Past) Theory
 FUNDAMENTAL APPROACH

▪ The Fundamental approach suggests that every stock/security has an

intrinsic value.

▪ Estimate of intrinsic worth of a stock is made by considering the

earnings potential of firm which depends upon investment
environment and factors relating to specific industry, competitiveness,
quality of management, operational efficiency, profitability, capital
structure and dividend policy.

▪ The earning potential is converted into the present value of the future
stream of income from that stock discounted at an appropriate risk
related rate of interest.

▪ Security analysis is done to compare the current market value of

particular security with the intrinsic or theoretical value.

▪ Decisions about buying and selling an individual security depends

upon the comparison. If the intrinsic value is more than the market
value, the fundamentalists recommend buying of the security and vice
versa.

Example 1
A Ltd had an security the market Price of which is Rs. 10,000. It Expect
to received dividend Rs. 1,000 in first year, Rs. 2000 at second year,
5,000 in 3rd Year. At the end of 3rd year, security will be sold for Rs.
15,000. calculate Intrinsic Value and decide whether to buy such
security. Interest Rate 15%.

TECHNICAL APPROACH

▪ The technical analyst endeavors to predict future price, levels of

stocks by examining one or many series of past data from the market
itself.

▪ The basic assumption of this approach is that history tends to repeat

itself and the price of a stock depends on supply and demand in the
market place and has little relationship with its intrinsic value.

▪ All financial data and market information of a given security is

reflected in the market price of a security.

▪ Therefore, an attempt is made through charts to identify price

movement patterns which predict future movement of the security.
 EFFICIENT CAPITAL MARKET THEORY

▪ The theory is popularly known as “Efficient Capital Market

Hypothesis: (ECMH).

▪ The advocates of this theory contend that securities markets are

perfect, or at least not too imperfect.

▪ The Efficient Capital Market Theory (ECMT) is a hypothesis in

financial economics that states that asset prices fully reflect all
available information.

▪ In an efficient market, all relevant information is incorporated into

prices, and it is impossible to consistently achieve higher returns than
the market average, except through luck or possessing private
information.

▪ The theory states that it is impossible to beat the market.

▪ Market efficiency was developed in 1970 by the economist Eugene

Fama, whose theory of efficient market hypothesis stated that it is not
possible for an investor to outperform the market because all
available information built in to all stock prices.

▪ For market efficiency, there are three essential conditions:

(a) All available information is cost free to all market participants;
(b) No transaction costs; and
(c) All investors similarly view the implications of available
information on current prices and distribution of future prices
of each security.

ALTERNATIVE APPROACHES TO SECURITY

VALUATION

1. RANDOM WALK THEORY

▪ The random walk theory is a concept which states that stock market
prices evolve according to a random walk and thus cannot be
predicted.

▪ According to this theory, the price changes are random and

unpredictable, following a path similar to a drunk person staggering
randomly.

▪ The theory suggests that it is impossible to consistently outperform

the market by using any information that the market does not already
know, as future price movements are independent of past movements.
▪ This implies that technical analysis, which attempts to predict future
price movements based on historical data, is not effective in beating
the market over the long term.

▪ However, critics of the theory argue that while stock prices may be
unpredictable in the short term, they may still be influenced by
fundamental factors in the long term.

▪ Research studies devoted to test the random walk theory on Efficient

Capital Market Hypothesis (ECMH) are put into three categories which
are as under:

(a) Strong Form: This form of the ECMH asserts that all
information, both public and private, is reflected in stock
prices. Therefore, no individual or group of investors can
consistently achieve above-average returns by using any
information that is not publicly available. Studies testing the
strong form typically examine insider trading activities to see if
insiders consistently earn abnormal profits.

(b) Semi-Strong Form: According to this form, stock prices fully

reflect all publicly available information. This implies that
fundamental analysis, technical analysis, and other methods of
stock analysis cannot consistently achieve above-average
returns.

(c) The Weak Form theory: This theory is an extension of the

random walk theory. According to it, the current stock values
fully reflect all the historical information. If this form is
assumed to be correct, then both Fundamental and Technical
Analysis lose their relevance. Study of the historical sequence
of prices, can neither assist the investment analysts or
investors to abnormally enhance their investment return nor
improve their ability to select stocks.
It means that knowledge of past patterns of stock prices
does not aid investors to make a better choice. The theory
states that stock prices exhibit a random behavior.

2. EFFICIENT MARKET THEORY

▪ Efficient Market Hypothesis accords supremacy to market forces.

▪ A market is treated as efficient when all known information is
immediately discounted by all investors and reflected in share prices.
▪ In such a situation, the only price changes that occur are those
resulting from new information. Since new information is generated on
a random basis, the subsequent price changes also happen on a
random basis.
 3. CAPITAL ASSETS PRICING MODEL (CAPM)

▪ CAPM explains the relationship between the Expected Return, Non-

Diversifiable Risk (Systematic Risk) and the valuation of securities.

▪ Under CAPM, Price of a security is calculated with the help of

expected return from security.
Formula for Computing Expected Return: E(RP) = Rf + (Rm –Rf {ß}

Where
E(RP) = Expected Return on Portfolio
RF = Risk Free Rate of Interest/ Return
ß = Portfolio Beta
RM = Expected Return on Market Portfolio

Example 2
Current yield on a U.S. 10-year treasury is 2.5%. The average excess
historical annual return for U.S. stocks is 7.5% The beta of the stock is
1.25

Ans. 11.875%

Example 3
Winner Corporation’s stock will pay a dividend of $1.32 next year. Its
current price is $24.625 per share. The beta for the stock is 1.35 and the
expected return on the market is 13.5%. If the riskless rate is 8.2%, what
is the expected growth rate of Winner Corporation?

Ans. Growth Rate = 10%

Example 3
Peak Services Ltd. common stock has a beta 1.15 and it expects to pay
a dividend of $1.00 after one year. Its expected dividend growth rate is
6%. The riskless rate is currently 12%, and the expected return on the
market is 18%. What should be a fair price of this stock?
Ans. Fair value of stock Rs. 7.75

Example 4
Wonderful Oil stock currently sells at $120 a share. The stockholders
expect to get a dividend of $ 6 next year, and they expect that the
dividend will grow at the rate of 5% per annum. The expected return on
the market is 12% and the riskless rate is 6%. Wonderful Oil announced
that it has won the multimillion-dollar navy contract, and in response to
the news, the stock jumped to $125 a share. Find the beta of the stock
before and after the announcement.

Ans. Beta Before Announcement 0.666, Beta after Announcement 0.633

 RETURN OF SECURITY
▪ Return is the primary motivating force that drives investment.

▪ It represents the reward for undertaking investment. One of the

important property of a security that the investors are concerned with
the return that can be expected from holding a security.

▪ Earning a return on an investment requires a passage of time. After

some time has passed, one may make an objective measurement of
the rate of an investment return that has been achieved.

▪ The word “return” can be misleading, since no single measure of

return can answer all possible questions regarding results. The
reasons lie in the fact that taxes, inflation, commissions, and the
timing of cash flows all play major roles in “correct” calculation of
returns.

TYPES OF RETURN

CURRENT RETURN CAPITAL RETURN

(REGULAR RETURN (PRICE CHANGE)

▪ The second component of

▪ The first component that
return is reflected in the
comes to mind when one is
price change called the
thinking about return is the
capital return
periodic cash flow (income),
such as dividend or
▪ is simply the price
interest, generated by the
appreciation
investment.
(or depreciation) divided
the beginning price of the
▪ Current return is measured
asset.
as the periodic income in
relation to the beginning
▪ Stock purchased for Rs. 100
price of the investment.
and sold for Rs. 120, such
Rs. 20 is capital return

HOW RETURN IS MEASURED

▪ Total return, or holding period return (r), is perhaps the best unique,
rational and comparable measures of results, no matter what type of
asset is under discussion.
▪ Holding period return is the total return received from holding an asset
or portfolio of assets over a period of time, generally expressed as a
percentage.
 HOLDING PERIOD RETURN (HPR) AND ANNUALIZED
HPR FOR RETURNS OVER MULTIPLE YEARS CAN BE
CALCULATED AS FOLLOWS:

▪ Holding Period Return = Income + (End of Period Value – Initial Value)

Initial Value

▪ Annualized Return =
(Annualized HPR means IRR is calculated on calculator as future
value/initial value. vo calculator par 12 baar rout vala concept)

Example 5
Mr. A invested Rs. 10,000 in shares of XYZ Company 10 years ago, and
that your shares (including reinvested dividends) are currently worth Rs.
23,800. Using this information, calculate total investment return of Mr.
A.
Ans. HPR = (23,800 – 10,000)/10,000 X 100 = 138%
Annualized HPR = 9.06%.
(This is calculated on calculator for using 12 baar route vala
concept)

Example 6
Three years ago, Fred invested $10,000 in the shares of ABC Corp. Each
year, the company distributed dividends to its shareholders. Each year,
Fred received $100 in dividends. Note that since Fred received $100 in
dividends each year, his total income is $300. Today, Fred sold his
shares for $12,000, and he wants to determine the HPR of his
investment.
Ans.
HPR = (300 + 12,000 – 10,000)/10,000 X 100 = 23%
Annualized HPR = 7.14% (Calculator par)

Example 7
What is the HPR for A, who bought a stock a year ago at $50 and
received $5 in dividends over the year, if the stock is now trading at
$60?
Ans. HPR = (5 + 60 – 50)/50 X 100 = 30%

Example 8
Which investment performed better:
Mutual Fund X, which was held for three years and appreciated from
$100 to $150, providing $5 in distributions, or Mutual Fund B, which went
from $200 to $320 and generated $10 in distributions over four years?
Ans.
Mutual Fund X
HPR = (5 + 150 – 100)/100 X 100 = 55%, Annualized HPR 15.73%
Mutual Fund B
HPR = (10 + 320 – 200)/200 X 100 = 65%, Annualized HPR 13.33%
 MISCELLANEOUS QUESTIONS
QUESTION 1
A Ltd has just declared a dividend of ` 46 per share. If the Investor
required rate of return is 20%, then what should be the price per share?

Ans. Rs. 230 per share

QUESTION 2
The analysts are of view that company YZ Ltd equity share will give a
return of 20% if the economy grows at a faster pace. If the economy
stays at the same rate of growth as in present times, then the equity
share is expected to give the return of 10% only. If the economic growth
rate goes down, the expected return of the share is only 5%. The
analysts further estimate that the probability of good, status quo and
recession of economy are: - 50%,30% & 20%. What is the average return
of YZ Ltd equity share?

Ans. 14%